An American Perspective from China

BBC: How Vulnerable is China?

The BBC today asked me to comment on how prepared Asia — and China in particular — is to survive a second economic downturn in Europe and the United States. Here’s what I had to say:

For the past year, ever since the eurozone crisis started to unfold, and it became clear the US was experiencing a very sluggish recovery, there’s been a great deal of apprehension in Asia, and China in particular, about a double-dip recession.

The big fear for China is that it will find itself back where it was at the end of 2008, with exports falling off a cliff because of a drop in US and European consumer demand.

If China does find itself in that situation again, there will be a very strong temptation for it to adopt the same response as last time around – a massive monetary stimulus that propped up the economy by financing a huge investment boom.

The problem is that China is already experiencing the hangover effects of that stimulus, in the form of burgeoning bad debts and rising inflation.

It can’t repeat the same thing again without making those problems much worse, and even precipitating a real economic meltdown at home.

The real solution, which China should have embraced much earlier, is to shift its economy away from a dependence on exports and investment to domestic consumption. But so far, the Chinese have been reluctant to do this, and if they try another round of stimulus, printing money to jack up investment, they’re going to be entering a real danger zone.

Several other economists offered their own perspectives, which you can read here. I’m still quite the outlier, it seems, in my concerns over the sustainability of China’s high rate of credit- and investment-driven growth.

And yet … here’s an excellent story in today’s New York Timesthat underlines those concerns. It talks about inflation, vacant real estate, bad debts, the growing dominance of the state sector — all the things that keep me awake at night. It goes on to quote my friend Evan Feigenbaum, director at the Eurasia Group:

“China’s leaders are committed to altering their country’s macroeconomic landscape,” Evan A. Feigenbaum, a China analyst at Eurasia Group, a global consulting firm, said in a statement attached to a report released Aug. 17. “But the country’s political economy will not change as fundamentally as many in China and abroad hope. And the next decade is likely to be more fraught than conventional wisdom suspects.”

Here’s a video clip with Evan appearing on Bloomberg to talk about that report and the challenges China faces. His message, as I read it: everyone (including China’s leaders) know where China needs to go, but whether there’s the will to go there is another matter.

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We all know what needs to be done. But to move to a consumer economy means losing control.
So export demand is falling and investment rates are unsustainable. China must move to a consumption based economy. This means either transferring spending power to citizens or government spending on behalf of its citizens (such as education, health care, perhaps even food stamp type programs).

Transferring spending power means the Party will have to trust consumers to spend in a socially beneficial manner. One can think of lots of examples where the Party has inserted itself to try to drive consumer choice and it has not worked. The deplorable box office performance of the latest state sponsored films is a good example.
I am very skeptical.

So, it may be that China will move toward entitlement style spending. However, I have to wonder where that money will come from? Most cities have no sustainable tax base. They are living off of land sales.
The stimulus for investment was debt financed and many of those loans are questionable. But if you move to consumption, you have nowhere to hide. You cannot finance such a deficit with a loan without calling it borrowing to fund expenses. (just ask the US). Maybe the central government can generate asset sales or begin to pay dividends from its massive SOE holdings and use those funds to pay for social programs. But those SOEs rely on continued cheap capital to be competitive. Paying dividends might be difficult. Selling all or a majority in these SOEs would mean ceding direct control.

I think there are ways to move to a more consumption based economy. I don’t think it will happen quickly and it also means the Party will lose some control over economic flows.

Patrick, picking up on your summation of Evan Feigenbaum’s message, would it be fair to say that “the will to go there” may be lacking, in part, due to the impending changes in political leadership? A case of “best not rock the boat for our successors”?
Do you think that the leadership may be more proactive in this regard were they to have a few more years in post?